Example Exercise 3 Estimating Uncollectible Accounts The two methods of estimating uncollectible accounts are: The percent of sales method Estimated as a percent of credit sales The analysis of receivables method Based on the assumption that the longer an accounts receivable is outstanding, the less likely it is that it will be collected. There are two methods used to estimate uncollectible accounts: [CLICK] the percent of sales method [CLICK] and the analysis of receivables method [CLICK]. The percent of sales method, illustrated in this example exercise, uses an estimate of uncollectible accounts as a percent of credit sales.

2 Example Exercise 3 Assume the following information Balance of Accounts Receivable $ 240,000 Balance of Allowance for Doubtful Accounts 3,250 Total credit sales 3,000,000 Bad debt as a percent of credit sales 1% (Cr.) Assume that a company had total credit sales of $3,000,000 and applied 1 percent to the credit sales to determine bad debt expense of $30,000 [CLICK]. Total credit sales $3,000,000 Bad debt as a percent of credit sales x 1% Bad debt expense $ 30,000

2 Example Exercise 3 The entry to record bad debts is a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts for $30,000. After the adjusting entry is posted to the ledger, Bad Debt Expense will have an adjusted balance of $30,000 and [CLICK] Allowance for Doubtful Accounts will have an adjusted balance of $33,250 [CLCIK]. Under the percent of sales methods, the amount of the adjusting entry is the amount estimated for Bad Debt Expense. As you can see here, the adjusted balance of Allowance for Doubtful Accounts is $3,250 larger than the estimated bad debts for the period. When the estimation is based on sales, the amount of the adjusting entry is not influenced by the balance of the allowance account.

2 Example Exercise 3 (a) Total credit sales $3,500,000 Bad debt as a percent of credit sales x .5% Bad debt expense $ 17,500 (a) In this example exercise, we need to first [CLICK] determine the amount of the adjusting entry for uncollectible accounts. Total credit sales are $3,500,000 and bad debts is estimated to be one half of one percent of credit sales. Therefore bad debt expense is calculated as $3,500,000 times one half of one percent, or $17,500 [CLICK].

2 Example Exercise 3 3 (b) For part (b), we need to determine the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense. [CLICK] As you can see from the T accounts shown, Accounts Receivable is unchanged at $800,000. Allowance for Doubtful Accounts has increased to $25,000 and Bad Debt Expense is now $17,500.

2 Example Exercise 3 (c) Accounts Receivable $800,000 For part (c), the net realizable value of accounts receivable [CLICK] is $775,000 calculated by subtracting Allowance for Doubtful Accounts of $25,000 from Accounts Receivable of $800,000. Accounts Receivable $800,000 Allowance for Doubtful Accounts (25,000) Net realizable value of accounts receivable $775,000 (c)

Example Exercise 3 3  For Practice: PE 3A, PE 3B 3 Refer to Practice Exercises PE 3A and PE 3B to practice on using the percent of sales method. 3A, 3B  For Practice: PE 3A, PE 3B